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OSC refuses to cease trade second rights plan adopted after bid announced - is it ever too late?

On May 11, the Ontario Securities Commission (the "Commission") rejected an application submitted by Pala Investments Holdings Limited ("Pala"), and its wholly-owned subsidiary, seeking a permanent cease trade order of two shareholder rights plans adopted by Neo Material Technologies Inc. ("Neo"). The second of the two plans, which was adopted "in direct response" to the partial take-over of Neo by Pala, was the subject of the OSC decision.

Background

Pala is a Jersey, Channel Islands based investment company which focuses primarily on mining and natural resource companies. On February 9, 2009, Pala announced, by way of a press release, that it intended to make an offer to purchase an additional 23 million shares of Neo at $1.40 per share (the "Pala Offer"). If successful, the offer would have resulted in Pala's ownership interest in Neo increasing from just over 20% to approximately 40%.

At the time of the press release announcing the Pala Offer, Neo had a shareholder rights plan that had been approved by shareholders in 2004 (the "Original Plan") and was subsequently confirmed by shareholders at its 2007 annual meeting. The Original Plan contained a "permitted bid" exemption, which imposed the following requirements:

that the bid be made to all shareholders;

that the bid remain open for at least 60 days;

that at least 50% of the shares, other than those held by the offeror, must be tendered pursuant to the bid (the "Minimum Tender Condition"); and

if the Minimum Tender Condition was met, the offer would remain open for another 10 days to permit additional shares to be tendered.

The Pala Offer was compliant with the permitted bid requirements of the Original Plan except for paragraphs (c) and (d).

Although the proposed Pala Offer was announced on February 9, the take-over bid circular was not filed until February 25, 2009. Interestingly, the notice setting out the record date and meeting date for Neo's annual meeting was posted on SEDAR the day after the announcement by Pala of the proposed Pala Offer. In any event, in the interim period, the board of directors of Neo ("Board") took customary steps to evaluate and respond to the Pala Offer including establishing a special committee of independent directors, appointing a financial advisor to evaluate the Pala Offer and appointing independent legal counsel for the special committee. The Board also seized the opportunity presented by the delay in filing the take-over bid circular to strengthen its defensive position. Three days after the press release announcing the proposed Pala Offer, the Board adopted a new shareholder rights plan (the "New Plan"). The terms of the New Plan were "substantially similar" to those in the Original Plan with the exception that, under the New Plan, a permitted bid would have to be made for all the Neo shares. The New Plan was put to shareholders at the annual meeting held on April 24 where it was approved by a vote of over 80% of the votes cast (excluding those cast by Pala).

On April 21, three days before the Neo shareholders' meeting, Pala announced its intention to amend the terms of the Pala Offer by increasing the price per share to $1.70 and decreasing the number of shares to be taken-up to a maximum of 10.6 million shares. Pala formally amended the Pala Offer three days after the Neo meeting on April 27 to reflect these changes. On May 15, Pala permitted the amended Pala Offer to expire.

The Application and Decision

The Commission rejected the application made by Pala to cease trade the New Plan. The Commission, in its expedited decision, explained that the New Plan was not contrary to the public interest and that it had been influenced by the following factors in arriving at its decision:

the New Plan was adopted in the context of and in response to the Pala Offer;

there was no evidence that the process undertaken by the Board, including the decision to implement the New Plan, was not carried out in what the Board determined to be the best interests of Neo and its shareholders;

an overwhelming majority of shareholders approved the New Plan while the Pala Offer remained outstanding;

the evidence supported a finding that the Neo shareholders were sufficiently informed about the New Plan prior to casting their votes; and

there was no evidence to suggest that management or the Board coerced or unduly pressured the Neo shareholders to approve the New Plan.

Commentary

As expected, the processes adopted and actions taken by the Board in responce to the Pala offer, including the amendment of the Original Plan, were scrutinized by the Commission. In its decision, the Commission concluded that there was no evidence that the Board had acted improperly in implementing the New Plan or that the Board coerced or unduly influenced the shareholders' decision. The tactical plan was placed before shareholders shortly after its adoption and received what was deemed to be convincing approval of the defensive actions taken by the Board in the face of the offer made by Pala. The New Plan was deemed to reflect the wishes of the shareholders of Neo who were adequately informed to make the decision.

In hindsight, it is difficult to understand why Pala announced the proposed offer by way of a press release rather than launch the bid by mailing its take-over bid circular from the outset. By issuing the press release, Pala appears to have provided Neo with the opportunity to evaluate the effectiveness of the Original Plan in the context of the Pala Offer. The 13 day delay between the announcement and the filing of the takeover bid circular appears to have given the Board sufficient time to evaluate the proposed bid and to change the rules to fit the circumstances raised by the Pala Offer.

In addition, had Pala filed the take-over bid circular at the outset, the 60 day clock would have started more than two weeks sooner. Although there is no indication that this would have been persuasive in the context of the Pala Offer, the additional time that the offer could have been outstanding may have given the Commission the rationale for concluding that the Neo pill "must go". Finally, in rejecting the application, the Commission notes that it was influenced by the fact that shareholders voted in favour of the New Plan while the Pala Offer remained outstanding.

Three days prior to the shareholders' meeting, Pala announced its intention to amend the terms of the Pala Offer to both increase the price and decrease the number of shares to be purchased. These changes heightened two of the primary reasons cited by the Board for adopting the New Plan, being that the Pala Offer undervalued Neo and that it was an attempt to acquire effective control without paying the appropriate premium. Given the importance of the shareholders' vote, it is interesting that Pala waited until three days prior to the Neo shareholders' meeting to make this announcement. Although not referred to by the Commission, it should be noted that this was one day before the deadline for submitting proxies and that, in response, Neo issued a press release waiving the deadline. However, the amended terms likely would not have been reflected in the votes of many shareholders given the short period available to assess the amended offer and to revoke their proxies if necessary.

Individually, such arguments may not have been persuasive or have changed the outcome of the vote. In the aggregate, they represent missed opportunities to present a stronger case before the Commission.

In the end, the Board was provided the ability to frustrate the offer even though the existing shareholder rights plan already provided nearly all of the protections available under the New Plan including providing additional time beyond the statutory minimum for the Board and Neo shareholders to consider the offer. There are undoubtedly tactical considerations on both sides that are not revealed in the public record. However, the message from the Commission appears to be that it will be prepared to permit amendments to existing shareholder rights plans where the board acts properly and receives timely and convincing approval of the shareholders for such amendments. What is left for a future decision is whether an amendment made to an existing shareholder rights plan in response to a permitted bid, after the filing of the take-over bid circular, would receive the same deference from the Commission as an amendment made prior to the filing of the take-over circular.